World View & Market Commentary. Forest first; Trees second. Focused on Real & Knowable facts that filter through the "experts" fluff and media hyperbole. Where we've been, what the future may hold and developing a better way forward.

Monday, October 12, 2009

The dollar is lower, currently at 76.37, oil is up, gold is up, and bond futures are up as well. The bond market is closed today due to it being Columbus Day. I am expecting lower volume in equities due to that, and there will be no economic releases today. Later in the week we get retail sales, the CPI, TIC flows, and Consumer Sentiment. There are also many earnings reports, GE, Goldman, JPM, and a total of 28 companies of the S&P 500 report this week. Keep in mind that the large banks are living a mark-to-fantasy world, high on fiat and big bonuses.

So far, the dollar has managed to hold above the 76 level. According to this Bloomberg article, however, central banks around the world are diversifying out:

Oct. 12 (Bloomberg) -- Central banks flush with record reserves are increasingly snubbing dollars in favor of euros and yen, further pressuring the greenback after its biggest two- quarter rout in almost two decades.

Policy makers boosted foreign currency holdings by $413 billion last quarter, the most since at least 2003, to $7.3 trillion, according to data compiled by Bloomberg. Nations reporting currency breakdowns put 63 percent of the new cash into euros and yen in April, May and June, the latest Barclays Capital data show. That’s the highest percentage in any quarter with more than an $80 billion increase.

World leaders are acting on threats to dump the dollar while the Obama administration shows a willingness to tolerate a weaker currency in an effort to boost exports and the economy as long as it doesn’t drive away the nation’s creditors. The diversification signals that the currency won’t rebound anytime soon after losing 10.3 percent on a trade-weighted basis the past six months, the biggest drop since 1991.

“Global central banks are getting more serious about diversification, whereas in the past they used to just talk about it,” said Steven Englander, a former Federal Reserve researcher who is now the chief U.S. currency strategist at Barclays in New York. “It looks like they are really backing away from the dollar.”

Sliding Share

The dollar’s 37 percent share of new reserves fell from about a 63 percent average since 1999. Englander concluded in a report that the trend “accelerated” in the third quarter. He said in an interview that “for the next couple of months, the forces are still in place” for continued diversification.

America’s currency has been under siege as the Treasury sells a record amount of debt to finance a budget deficit that totaled $1.4 trillion in fiscal 2009 ended Sept. 30.

Intercontinental Exchange Inc.’s Dollar Index, which tracks the currency’s performance against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, fell to 75.77 last week, the lowest level since August 2008 and down from the high this year of 89.624 on March 4. The index, at 76.431 today, is within six points of its record low reached in March 2008.

Foreign companies and officials are starting to say their economies are getting hurt because of the dollar’s weakness.

Dollar’s Weighting

Developing countries have likely sold about $30 billion for euros, yen and other currencies each month since March, according to strategists at Bank of America-Merrill Lynch.

That helped reduce the dollar’s weight at central banks that report currency holdings to 62.8 percent as of June 30, the lowest on record, the latest International Monetary Fund data show. The quarter’s 2.2 percentage point decline was the biggest since falling 2.5 percentage points to 69.1 percent in the period ended June 30, 2002.

“The diversification out of the dollar will accelerate,” said Fabrizio Fiorini, a money manager who helps oversee $12 billion at Aletti Gestielle SGR SpA in Milan. “People are buying the euro not because they want that currency, but because they want to get rid of the dollar. In the long run, the U.S. will not be the same powerful country that it once was.”

Central banks’ moves away from the dollar are a temporary trend that will reverse once the Fed starts raising interest rates from near zero, according to Christoph Kind, who helps manage $20 billion as head of asset allocation at Frankfurt Trust in Germany.

‘Flush’ With Dollars

“The world is currently flush with the U.S. dollar, which is available at no cost,” Kind said. “If there’s a turnaround in U.S. monetary policy, there will be a change of perception about the dollar as a reserve currency. The diversification has more to do with reduction of concentration risks rather than a dim view of the U.S. or its currency.”

The median forecast in a Bloomberg survey of 54 economists is for the Fed to lift its target rate for overnight loans between banks to 1.25 percent by the end of 2010. The European Central Bank will boost its benchmark a half percentage point to 1.5 percent, a separate poll shows.

America’s economy will grow 2.4 percent in 2010, compared with 0.95 percent in the Sentiment toward the dollar reminds John Taylor, chairman of New York-based FX Concepts Inc., the world’s largest currency hedge fund, of the mid-1990s. That’s when the greenback tumbled to a post-World War II low of 79.75 against the yen on April 19, 1995, on concern that the Fed wasn’t raising rates fast enough to contain inflation. Like now, speculation about central bank diversification and the demise of the dollar’s primacy rose.

The currency then gained 26 percent versus the yen and 25 percent against the deutsche mark in the following two years as technology innovation increased U.S. productivity and attracted foreign capital.

“People didn’t like the dollar in 1995,” said Taylor, whose firm has $9 billion under management. “That was very stupid and turned out to be wrong. Now, we are getting to the point that people’s attitude toward the dollar becomes ridiculously negative.”

I would agree that the sentiment has gotten pretty negative, and it is at extremes that turns usually happen. We definitely have a long term structural problem, but keep in mind that nothing moves in that proverbial straight line. That said, if the dollar were to get below 76 and move to 72, it might not prove to be as good for equities as has been the case so far.

Last Friday produced another small movement in the McClelland Oscillator. Usually movements less than 10 produce big changes within the following two days, the change in the McClelland on Friday was 12 which is pretty darn small, so be aware that a large change is possible today or tomorrow.

We got above the 1,070 level and are retesting the old highs at 1,080. It is possible to double top in here so be alert for that. The 1,090 pivot level may help to hold prices in this range for awhile, if that is breached, the next higher pivot is 1,107 while current support is at 1,061.

The daily, 60, 30, and 10 minute stochastics are all overbought. The wave count is in a position for wave 3 up of 5 up (technically wave E) to be in progress. It should produce a new high (already did in the DOW) and then there should be a wave 4 and then 5 to finish up the large wave B up. Pay attention to the Transports, they are not nearly as close to a new high as the rest of the indices and so there's potential for a DOW Theory non-confirmation.

I am still watching the rising wedges as pictured below. It’s very common to see those overthrow the top or to fall short of the top as the last wave up progresses. You will know that wave B is complete once the bottom uprising trend line is broken. Note the classic declining volume as these rising wedges have progressed: